SAN FRANCISCO (Reuters) – Yahoo CEO Carol Bartz is known as a strong-willed and straight-talking leader, but some top money managers are betting she can mend fences and compromise with crucial partners in China.

Shares of Yahoo Inc, at around $16, are just over half what they were in 2008 when Microsoft came calling, never mind the Internet bubble highs of a decade ago.

But the stock's potential rebound attracted top hedge fund managers David Einhorn of Greenlight Capital, Philippe Laffont of Coatue Capital, Anand Parekh of Alyeska Investment Group and Ricky Sandler of Eminence Capital in the first quarter. The buying spree made Yahoo one of the biggest additions to portfolios of the Smart Money 30, a group of the largest stock-picking hedge funds, according to Thomson Reuters data.

Analysts say most investors have undervalued the most exciting part Bartz's Yahoo portfolio: its substantial Asian assets, which include a 43 percent stake in China's Alibaba Group and a 35 percent stake in Yahoo Japan.

But Bartz has had a tough time dealing with some of her Asian partners, particularly Alibaba Group founder Jack Ma, as investors discovered in early May.

That's when Yahoo revealed that online payment company Alipay, an important piece of its Chinese investment, had slipped through its fingers as a result of an asset transfer that raised questions about what kind of payout Yahoo's Asia assets will deliver. Yahoo shares tumbled 12 percent in the days that followed.

Bartz got off to a bad start with Ma, a former English schoolteacher, by criticizing his management of Yahoo's brand in China during their first meeting in 2009, according to a person familiar with the matter.

And Ma was subsequently rebuffed in efforts to repurchase some of Yahoo's stake in his company.

The two companies are currently in negotiations over how to compensate Yahoo for Alipay, an Alibaba subsidiary that was transferred to a separate entity controlled by Ma in order to meet Chinese regulations relating to foreign ownership.

But the Alipay transfer was in fact a case of "bad news is good news," according to Adam Seessel, portfolio manager of the RiverPark/Gravity Long-Biased Fund, which counts Yahoo as its largest position.

Ma values his reputation on the world business stage too much to try to wrest control of the assets away from Yahoo without offering compensation, Seessel said. Instead, he reckons Ma will use his leverage to force Bartz's hand at the negotiating table and make Yahoo sell back its entire 40 percent stake in Alibaba.

"There's no risk that they're going to lose these assets," he said of Yahoo. "What's happened is the timetable for monetizing these assets has been radically shortened because Jack Ma wants his stake back."

To be sure, the scenario seems too risky for some investors.

"There's more uncertainty in terms of will Yahoo be able to get the full value of these assets," said Aaron Kessler, an analyst at ThinkEquity. But he noted that with Yahoo shares currently trading at around $16, the market isn't assuming much value for the Chinese assets to begin with, leaving room for upside.

Daniel Morgan, a portfolio manager at Synovus Trust Co, said he was more interested in seeing a turnaround in Yahoo's core business than he was in gambling on a potential payoff from Yahoo's Asian assets, particularly in the wake of the Alipay situation.

"There's got to be more to it than just speculation surrounding something that could happen," he said.

Still, the allure of China, the world's largest Internet market by number of users, is hard to resist. Shares of Baidu Inc, China's No. 1 search engine, have surged 32 this year, while Chinese Web portals SINA Corp and Sohu.com Inc have risen 59 percent and 24 percent, respectively.

While Western Internet companies like Google Inc have struggled to crack the Chinese market, notorious for its murky regulatory landscape, Yahoo's partnership with local player Alibaba was considered a shrewd way to tap into the fast-growing Chinese market -- particularly given that Yahoo acquired its sizable stake in Alibaba for the bargain price of $1 billion in 2005. Some investors believe privately-held Alibaba's value currently exceeds $40 billion.

The fate of Taobao, an Alibaba subsidiary that is considered the eBay of China and deemed more valuable than Alipay, could be of even greater concern to Yahoo investors.

Some investors, such as RCM Capital Management Portfolio Manager Walt Price, believe Taobao could be poised for an initial public offering in 2012, providing a boost to Yahoo's shares.

Price doesn't see much risk of the Chinese government barring Yahoo from owning a stake in Taobao, as occurred with Alipay, noting that the e-commerce industry is of less concern to Chinese authorities than payment businesses. But he said Bartz and company need to make nice with Alibaba to clear the way for a Taobao IPO.

"They just have to repair the relationship and compromise maybe a little bit on the ownership structure. If they do that, they're going to own one of the most valuable companies in China and Yahoo's stock is going to go higher."

It's not the first time that Yahoo's fortunes have been closely intertwined with another Internet juggernaut. Yahoo shares reached $30 in 2008 amid negotiations about an acquisition by Microsoft Corp.

Yahoo co-founder and then CEO Jerry Yang rebuffed a $47.5 billion offer by Microsoft, sending Yahoo shares on a downward slide from which they have never recovered.

This time around, investors betting on the pioneering Web company expect Bartz to close the deal.

(Reporting by Alexei Oreskovic; editing by Aaron Pressman and John Wallace)